URNM - Smart Picks For Tax Loss Harvesting: Top 4 ETFs

2023-12-20 05:00:00 ET

Summary

• Tax loss harvesting is a strategy where investors offset capital gains with securities they sell at a loss to reduce their overall tax liability.
• Markets rallied to kick off 2023, but major indexes declined for three consecutive months to start Q4. In October, the S&P 500 lost 2.2%, the DJI fell 1.4%, and ND lost 2.8%.
• Despite Q3’s crushing blows and many stocks underperforming the S&P 500 on the year, ETFs and stocks with good fundamentals offer an opportunity for tax loss harvesting.
• Selling underperforming stocks and ETFs, especially those that took a hit during Q3 or lagged throughout the year, could favorably impact assets poised for capital gains distributions as 2023 comes to a close.

The bad news bears delivered crushing blows to global equities in the third quarter, as rising inflation and wars contributed to an October that delivered the month’s worst stock performance since 2018. Despite equity markets rallying in the first half of 2023, fear of Fed rate hikes, Fitch Ratings' downgrade of US debt from AAA to AA+, global conflicts, and surging bond yields led to stock declines, resulting in all major asset classes experiencing negative returns in August and September. For October, the S&P 500 lost 2.2%, while the Dow Jones and NASDAQ fell 1.4% and 2.8%, respectively.

In 2023, the S&P 500 was also a tale of two stories, as most of the gains were driven by the seven largest market cap stocks. Subtract these seven stocks, and the S&P 493 was only up 7.29% compared to 20.75% for the S&P 500 by the end of November. Many Mid-cap and small-cap stocks were down during 2023 on the basis of economic concerns.

In 2023, 7 stocks were largely responsible for driving the S&P 500

While some investors and active money managers have cut equity exposure, smart investors are turning stock losers into winners for year-end – a strategy known as tax-loss harvesting.

Tax-loss harvesting

Turn portfolio losers into winners! Tax-loss harvesting allows investors to sell beaten-down investments at a loss and replace them with similar securities to offset capital gains from winning investments. The potential result is less money paid toward taxes and more money to invest and put to work.

Tax-loss harvesting is a smart strategy that allows investors an opportunity to lower their tax bill, so I asked my team to interview Chris Osmond , CFA, CAIA®, CFP®, Partner and Chief Investment Officer of Centura Wealth Advisory, to shed light on the benefits of tax-loss harvesting at year-end.

Chris Osmond has served in leadership roles for some of the most prestigious Trust Wealth Management departments, including Northern Trust, US Bank Private Wealth Management, and BMO Harris Private Bank. Osmond creates and manages custom investment management solutions. Before his current role, Chris served as Chief Investment Officer for a $3.5B Registered Investment Advisor ((RIA)), significantly contributing to the firm’s growth to $17B, and he was a frequent contributor to media outlets like Bloomberg, CNBC.com, Reuters, and Yahoo Finance.

Osmond oversees investment strategies and guides investment policy, developing traditional and alternative investment platforms. As a big proponent of rebalancing investment portfolios, Osmond advises that tax-loss harvesting is generally best when incorporated in performing portfolio rebalances. To bring each investment in line with its target allocation, rebalancing helps ensure investors maintain their appropriate risk-reward profile. For illustrative purposes only, the visual below highlights how capital losses can be used to offset capital gains.

How tax-loss harvesting typically works

1. Sell Portfolio Losers : Selling securities for a value less than you paid creates a realized capital loss.
2. Offset Gains : Capital losses can be used to offset the gains from other investments that have rallied in the same tax year. If the capital losses exceed the capital gains, there are limits to deductions and carryover losses.
3. Tax Benefits : Investors potentially reduce their tax burden through strategic planning and realizing losses to offset yearly gains. Osmond states, “Investors can sell every position or tax lot with unrealized losses, locking in losses to offset gains. Tax-loss harvesting is most advantageous when unrealized losses are short-term because they are taxed as ordinary income. The money saved on taxes can be reinvested to compound investment returns.”

While there are many tax benefits to tax-loss harvesting, there are also some drawbacks, which include wash sale rules.

What is a wash sale?

The wash sale rule was implemented in 1921 and states that if an investor sells an investment at a loss, the investor may not buy that security or a substantially identical security back for 30 days. Investors with a high conviction in a stock may miss an abrupt rebound if they engage in tax-loss harvesting. Still, a wash sale occurs if an investor sells a losing security but decides to repurchase the identical security or one very similar within 30 days. Wash sales can occur with any security, but unlike stocks, ETFs offer benefits that can benefit investors wanting to capitalize on portfolio losses.

Stocks vs. ETF: Which Should You Invest In?

Investing in individual stocks allows investors to own shares of specific companies, sectors, and industries with the potential for higher returns if they perform well. Unlike individual stocks, Exchange-traded funds (ETFs) offer a basket of securities. A basket provides greater diversification and decreased risk compared to individual stocks.

ETF diversification spreads risk across multiple assets, sectors, and industries to mitigate the downside during market volatility. As we saw this year, the market can rapidly turn, so I’ve written this article to highlight the advantages ETFs offer and the opportunity to use them for tax-loss harvesting.

4 ETFs To Invest In

The performance of the S&P 500 in 2023 has been extremely concentrated by the ten largest stocks, which currently comprise approximately 30% of the overall index. Big Tech constituents primarily drove most of the benchmark's return, with the total return for the Magnificent 7 (Apple, Microsoft, Amazon, Nvidia, Meta, Alphabet, and Tesla) accounting for over 75% through November. Through December 8th, the S&P 500 is up 20.31%, while the average stock, represented by the S&P 500 Equal Weight ETF ( RSP ), is up only 6.40%. Osmond said he’s rarely a fan of “letting the tax tail wag the investment dog” when investors face large gains but says tax loss harvesting can effectively reduce one’s tax liability.

"It’s also important to maintain one’s long-term risk/reward profile with investing, which suggests investors remain invested. When tax loss harvesting, it’s no different. When selling a security, replacing that holding with a similar investment from a risk and exposure perspective is important. To maintain this balance, my preference is to opt for a diversified ETF that aligns with the securities I’m selling. Additionally, I prefer to select an ETF that holds the securities I’m selling to obtain indirect exposure. Two examples:

1. Assume you own each of the stocks that make up the Magnificent Seven, and you somehow have an unrealized loss in each and decide to harvest those losses to offset realized gains incurred over the course of the year. The Invesco QQQ Trust ( QQQ ), which tracks the 100 largest companies in the NASDAQ Composite, might be a viable solution to consider, as the Magnificent Seven make up nearly 44% of that ETF (including both Alphabet share classes).

2. If the only losses in my portfolio are regional banks that haven’t yet recovered from the contagious collapse of Silicon Valley Bank and First Republic Bank, I may look to purchase a regional bank ETF like the iShares U.S. Regional Banks ETF ( IAT ), the SPDR S&P Regional Banking ETF ( KRE ), or even the Invesco KBW Regional Banking ETF ( KBWR ), selling losses, while regaining exposure to these banks at a discount."

That being said, let’s dive into Steve Cress' top ETFs for end-of-the-year tax-loss harvesting.

US Equity ETFs

US Equity ETFs offer exposure to diversified assets within various sectors and industries in the U.S. markets and typically track the S&P 500, Dow Jones, or Russell 2000. Here are four Quant Buy-rated ETFs.

1. Invesco QQQ Trust ETF ((QQQ))

• Assets ((AUM)): $227.89B

• Quant Rating: Buy

• Quant Ranking in Asset Class (as of 12/18/23): 1 out of 586

• Quant Ranking in Sub Class (as of 12/18/23): 1 out of 79

A popular large growth fund that generally tracks the price and yield performance of the Nasdaq-100 Index®, Invesco QQQ Trust ETF ( QQQ ) offers exposure to innovation and some of the hottest tech names. Up more than 53% YTD, the QQQ is one of the best ETF performers this year, with strong historical performance, outperforming the broader market over the last three-, five-, 10-, and 20-years.

QQQ ETF Holdings Breakdown

2. Vanguard Mega Cap Growth Index Fund ETF Shares ( MGK )

• Assets ((AUM)): $15.81B
• Quant Rating: Buy
• Quant Ranking in Asset Class (as of 12/18/23): 10 out of 586
• Quant Ranking in Sub Class (as of 12/18/23): 3 out of 79

Like QQQ, the Vanguard Mega Cap Growth Index Fund ETF ((MGK)) has tech-heavy holdings, including Apple, Microsoft, and Amazon. MGK operates across diversified sectors, focusing on tracking the performance of the CRSP US Mega Cap Growth Index using a full replication technique. Managed by the Vanguard Group, MGK showcases tremendous fundamentals.

Vanguard Mega Cap Growth Index Fund ETF Grades

MGK offers 14 years of consecutive dividend payments for investors looking for a consistent income stream. However, the dividend yield on growth stocks is generally low relative to other equities, like value stocks. Additionally, the ETF has tremendous momentum, as showcased in its A+ grade above a very low expense ratio relative to its sector peers. Consider this ETF for a portfolio, and my Sector Equity ETF picks.

Sector Equity

Part of a diversified investment strategy, sector equity ETFs give investors a target-specific focus in their preferred industries or sectors of the economy. Investors wanting to concentrate on energy, financials, consumer goods, etc., can target those ETFs they believe will outperform the broader market.

3. Sprott Uranium Miners ETF ( URNM )

• Assets ((AUM)): $1.62B
• Quant Rating: Strong Buy
• Quant Ranking in Asset Class (as of 12/18/23): 1 out of 385
• Quant Ranking in Sub Class (as of 12/18/23): 1 out of 36

Nuclear energy has been headline news, as it plays a vital role in providing cost-effective, dependable, and scalable power sources. Co-managed by ALPS Advisors, Sprott Uranium Miners ETF is quant-rated a Strong Buy. This ETF is designed to track the performance of uranium assets, including mining, exploration, development, and production.

URNM ETF Momentum Grades

With tremendous momentum and a focus on stocks of companies across energy, oil, gas, and consumable fuels, this ETF invests in public equity markets of a global region and seeks to track the performance of the North Shore Global Uranium Mining Index by using a full replication technique. Up 56% YTD and 63% over the last year, URNM is focused on meeting increased energy demands. As analyst Michael Wiggins De Oliveira highlighted ,

“Investors who understand the need for uranium but don't want to figure out how to invest in this space may consider investing in an ETF, like the Sprott Uranium Miners ETF.”

International Equity

Where access to investments in some foreign markets may be difficult, investors seeking global diversification, a hedge against U.S. currency risks, or potential exposure to up-and-coming economies can look to international equity ETFs.

4. Global X MSCI Argentina ETF ( ARGT )

• Assets ((AUM)): $114.89B
• Quant Rating: Strong Buy
• Quant Ranking in Asset Class (as of 12/18/23): 1 out of 428
• Quant Ranking in Sub Class (as of 12/18/23): 1 out of 60

Argentina has been a strong economic powerhouse, one of the largest economies in South America, with a U.S. GDP of over $650B and a vast array of natural resources. Seeking to track the performance of the MSCI All Argentina 25/50 Index, the Global X MSCI Argentina ETF ((ARGT)) has delivered tremendous results, +57% YTD and +64% over the last year, with its biggest holding in online commerce platform MercadoLibre ( MELI ).

ARGT ETF Holdings Breakdown

On an uptrend, this ETF has continued to showcase strong performance, paying seven years of consecutive dividend payments and substantially outperforming its median ETF peers on three- and five-year CAGR dividend growth. Although Argentina has been faced with geopolitical and macro headwinds, the nation has weathered the storms overarchingly. Michael A. Gayed, CFA, writes ,

While ARGT has seen a rally in the YTD period, the valuations still trade below their underlying earnings growth potential, making the ETF an attractive investment.

There’s a world of unique investment opportunities beyond traditional stocks and bonds to complement traditional investments, including Alternative ETFs and the EFTs I mentioned above. Access to crypto or strategies like private equity, private debt, hedge funds, etc. that the average investor may not have access to can be accessed through ETFs, offering diversification and potential growth and income. As tax time and year-end approaches, consider taking advantage of losses by turning them into tax winners. There are many smart ETF picks for investors looking to capitalize on selling securities to offset their gains.

Conclusion

Buy low, sell high is a common investment strategy. Selling securities for less than the price paid to capture losses and offset gains defines tax-loss harvesting. This strategy can prove beneficial for tax planning, as highlighted by Amit Poddar, senior vice president and market leader for U.S. Bank Private Wealth Management:

We see a lot of investors who want to capture losses between Christmas and New Year…Start thinking of harvesting in the fall and start executing a chosen plan much ahead of the late December deadline.

War, inflation, slowing economies, and market volatility have resulted in market uncertainty, prompting many investors to go to cash, incurring capturing gains while looking for ways to help offset portfolio losses. Create a Seeking Alpha portfolio to see if the stocks you follow carry Strong Sell or Strong Buy Quant ratings.

Seeking Alpha’s quant ratings and investment research tools help to ensure you are furnished with the best resources to make informed investment decisions while taking the emotion out of investing. We have many securities with strong buy recommendations. SA Quant ratings warn of securities with poor metrics while allowing investors to screen for stocks and ETFs to filter for securities that suit specific investment objectives. Browse our Top Rated ETFs and Top Rated Stocks , or if you're interested in a monthly selection of the best of Seeking Alpha’s 'strong buy' quant stocks, limited to just two top ideas each month, Alpha Picks might be ideal. Tax-loss harvesting can benefit investors, but speaking with a financial or tax professional is crucial to see if the strategy is right for you.

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